Pay-when-Paid and Pay-if-Paid Contract Provisions

One of the greatest concerns and risks on a construction project is payment by the owner. Once the contract work has been fully performed, everyone wants to be, and should be, fully paid. One of the risks of nonpayment is the owner's potential inability to pay or unwilingness to pay. Contractors need to agree on who bears the risk of nonpayment ‚Äď the general contractor or the subcontractor.

Contractors routinely try to shift the burden of nonpayment to subcontractors. "Pay when paid" and "pay if paid" provisions are popular. Most "pay when paid" clauses only serve to delay the time for payment to the subcontractor, whereas a properly worded "pay if paid" clause may actually shift the burden of nonpayment to the subcontractor.

Typical pay when paid clauses provide something like:

"The total price paid to [subcontractor] shall be [contract price], no part of which shall be paid until 5 days after payment is received from owner."

or

". . . the Contractor shall pay the Subcontractor each progress payment and final payment . . . within three working days after he receives payment from the Owner . . . ."

In Transtar, the Ohio Supreme Court held that the following contract clause constitutes a pay-if-paid provision:

The Contractor shall pay to the Subcontractor the amount due [for work performed] only upon the satisfaction of all four of the following conditions: . . . the Contractor has received payment from the Owner for the Work performed by Subcontractor. RECEIPT OF PAYMENT BY CONTRACTOR FROM OWNER FOR WORK PERFORMED BY SUBCONTRACTOR IS A CONDITION PRECEDENT TO PAYMENT BY CONTRACTOR TO SUBCONTRACTOR FOR THAT WORK. (Emphasis sic.)

In Transtar, the owner did not pay the general contractor for the work performed by the subcontractor Transtar. The Court noted in its decision that Transtar had fully performed its work, and there is no mention in the decision why the general contractor was not paid, or what steps the general contractor had taken to secure payment.

In so ruling, the Supreme Court overturned the decision by the Lucas County Court of Appeals which held that the provision was insufficient to establish a pay-if-paid provision. "While the words 'condition precedent' may be helpful, the term is not sufficiently defined to impart that both parties understand that the provision alters a fundamental custom between a general contractor and a subcontractor." The Supreme Court disagreed with the Court of Appeals, holding that the contract language was sufficient to shift risk of payment.

The Supreme Court relied on Thos. J. Dyer v. Bishop International Engineering Co., where the Sixth Circuit U.S. Court of Appeals refused to enforce a pay-if-paid clause. In Dyer, a general contractor was not paid on a project after the owner declared bankruptcy. The general contractor, in turn, did not pay its subcontractor for the work it performed.

The Sixth Circuit held that conditions on payment are enforceable, so long as such conditions are clearly expressed. In construing the clause that "no part [of payment] shall be due until five days after the owner shall have paid the contractor," the court decided that the clause was sufficiently ambiguous to require examination of the parties' intent. In examining the parties' intent, the court noted that general contractors normally bear the risk of nonpayment due to insolvency. The court held that this normal relationship could be varied only with clear and unequivocal language.

Accordingly, the Dyer court held that the payment clause was a pay-when-paid clause and was only effective to delay payment "for a reasonable period of time after the work was completed, during which the general contractor would be afforded the opportunity of procuring from the owner the funds necessary to pay the subcontractor."

How do contractors safely shift the burden of nonpayment by the owner? Say it clearly in a contract provision. What should be said? The contract should state that:

the subcontractor is paid only if the general contractor is paid, (or the subcontractor will not be paid unless the general contractor receives payment from the owner)

and

the subcontractor assumes the risk of nonpayment by the owner due to insolvency or other inability to pay.

Still unsettled is the effect of the general contractor's actions on the failure of the owner to pay. Consider the following:

Was the subcontractor's work properly invoiced? If not, the pay-if-paid provision may not apply to the work not invoiced.

Was the subcontractor's work for a change order that was approved by the general contractor but not approved by the owner? If so, the pay-if-paid provision may not apply to that work that was approved by the general contractor's change order.

Was the reason for the owner's refusal to pay based on the general contractor's actions or inactions? This may also adversely effect the application of the pay-if-paid provision.

Has the general contractor make a reasonable and good faith effort to collect the unpaid amounts? It seems as though the general contractor is obligated to pursue payment from the owner.

We hope you enjoy the photos on this page and find them interesting. The photos were taken by Peter Gostelow during a bicycle tour while in Tibet. You can see more of Peter's photos at www.petergostelow.com.